Captive Insurance Risk Pooling Explained
According to Bruce Wright of Eversheds Sutherland, risk pools in captives (1) allow organizations to spread risk and (2) provide for a tax benefit. Risk pools provide unrelated risk to a captive insurer so that the parent corporation can take a deduction for premium paid to the captive by reporting on the insurance method of accounting. The elements of insurance (for federal income tax purposes) are (1) risk transfer, (2) risk distribution, and (3) common elements of insurance. The focus of risk pooling has to do with risk distribution.
A pool is an arrangement where organizations share risk. A sound pool should have (1) similar risks, (2) a common underwriting methodology, (3) a pool manager, (4) the potential for loss or gain, and (5) setup on an annual basis. There are different types of structures for pools, such as a (1) reinsurance treaty, (2) pooling entity, or (3) fronting company.